What should your business model be: Free, “Freemium”, or Paid Content?

How can you make money off of a free product?
Chris Anderson writes in “Giving it All Away” in today’s WSJ that the classic example is the two-sided model, where a small number of paying customers (AdSense buyers or TV ad buyers, for example) subsidize the vast majority of users (Google or TV) and that is a self-fulfilling feedback loop. More eyeballs == more potential buyers == the highest CPM (if, of course, some of these customers buy the product). Anderson posits that new business models, such as “Freemium” (most users free, some users pay for increased functionality), have exploded in popularity as the marginal cost of giving you more digital bits heads to zero. This is very similar to the Microsoft model of providing you with different models of the same OS, unlocked by different serial numbers. The basic cost to write and build the software is the same no matter who buys it. It’s the revenue end that’s tricky.

John Gourville’s classic article on the resistance sellers face from buyers gives us a few directional ideas on what to expect. The realistic possibilities (absent a very complicated model like Airline pricing where practically everyone pays a different price) for many new and current businesses are free (most likely ad-supported); “freemium”, where the few paying customers support the many non-paying customers; and paid content, where the information is not available unless you pay. Which model should you choose?

Free — where nobody pays, or do they?
Free* is the title of the newest Jim’s Big Ego album. This Boston based group is following in the tradition of the tip jar by providing a version of the new album that you can download for nothing. If you like it, buy the physical album, or simply contribute to the band. Radiohead tried this gimmick last year, and eventually ended it because, presumably, there was no reason to download something from Radiohead that you could get anywhere. Gourville’s premise — based on the research showing that buyers want something three times better than what they have, and that sellers overvalue what they are selling by up to a factor of three — is that something new has to be nine times better than what went before to get. What’s nine times better than free? If you are a world-famous band like Radiohead, it’s probably good enough publicity to give away an album when you are handling the distribution yourself instead of using a record label. But maybe not for your business.

“Freemium” — where the needs of the few trump the needs of the many
Freemium“, or the practice of giving away a version of your product or service for free, is a digital version of the “loss leader” practiced by many brick and mortar stores. Get enough people talking about your product, the theory goes, and eventually enough of them will buy and make up the difference. Your overall average price may be lower, but you have a larger potential pool of customers. LinkedIn and Flickr are excellent examples of this business model, and by segmenting the customer base, savvy marketers can find highly profitable niches (for LinkedIn, it’s turned out to be recruiters; for Flickr, some professional photographers looking for additional exposure — no pun intended). This model, however, hasn’t worked out so well for Twitter, which is wildly popular yet seeking a business model; and Facebook, which should be an ad machine but curiously produces low CPM rates. I’m cautiously optimistic on this model, because the really active, paying users will create the equivalent of the classic two-sided model. The iTunes store shows that if you can price your app correctly, you can be very very successful because the volume of users is so large.

Paid Content — the Holy Grail, but no one really wants it
The Wall Street Journal was the poster child for paid content on the web. The Journal trumpted its paid subscriber base and boasted that it was one of the only sites on the web actually making money through paying customers. Yet a funny thing happen last year: the Journal opened up its pages. Why give the milk away when you can get the cow for free? Obviously the beancounters at the Journal decide that they could make more than the estimated $75m/yearly revenue through ads. So why didn’t the WSJ continue its walled garden?

Tight Niches equal Profit Potential
The Journal opened its walls because there were free substitutes available. From Google News to the Daily Huffington Post to your local newspaper, you can read the news in lots of places. One example of a highly targeted niche is PayBefore, an online resource for the prepaid card industry. This site offers news, opinion, and information to “the prepaid and stored value card industry”, which is essentially a trade magazine online. But no one else is covering this particular trade — hence the profit potential.

So, what now? Which model makes the most sense for my business?
Ask yourself a few easy questions:

  • What am I doing to create, communicate, and deliver unique value?
  • Is my offering 9x (or 10x) better than the substitute people might otherwise choose?
  • Why would users come back over and over again, and tell their friends?.

If the answer to all three of these questions is yes, then you’ve probably got a niche that could be served well by a Paid Content offering. Yet you should ask yourself — how could I increase my reach by broadening the potential appeal — and create a free offering that will seed future customers and provide a feedback loop for growth.


3 thoughts on “What should your business model be: Free, “Freemium”, or Paid Content?

Add yours

  1. (Well, actually… If one’s literal answer to all three of these questions is “yes,” then one may want to reread them prior to any fancy-schmancy strategizing….)

  2. Great article Greg. For those who are a part of the start-up game, this seems to be the question of the day! Ventures such as Google, have opened up the “free” market, and caused paid subscribers to question their expenses. And yet, there lies the question of revenue. Your business isn’t good if you don’t have a source of revenue. Isn’t it the first question that a VC asks, even before the pitch? And perhaps the greatest source of “free” revenue is ads, which prompt the question of “How good is your marketing?” I’ve heard a number of different arguments, and I must say, I like your take on the stance. Keep up the good work!

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